Notes from Howard's Sabbatical from Working. The name comes from a 1998 lunch conversation. Someone asked if everything man knew was on the web. I answered "no" and off the top of my head said "Fidel Castro's favorite color". About every 6-12 months I've searched for this. It doesn't show up in the first 50 Google results (this blog is finally first for that search), AskJeeves says it's: red.

Wednesday, May 26, 2010

So Much For Real Financial Reform

I haven't read too much on the financial reform bill that's comprehensive, probably because the House and Senate versions need to be reconciled. But the economists I read seem to be down on it as not doing enough.

Robert Reich wrote Obama's Regulatory Brain. "The most important thing to know about the 1,500 page financial reform bill passed by the Senate last week — now on he way to being reconciled with the House bill — is that it’s regulatory. It does nothing to change the structure of Wall Street."

"First, although the Senate bill seeks to avoid the “too big to fail” problem by pushing failing banks into an “orderly” bankruptcy-type process, this regulatory approach isn’t enough. The Senate roundly rejected an amendment that would have broken up the biggest banks by imposing caps on the deposits they could hold and their capital assets."

"Another crucial provision left out of the Senate bill would be to change the structure of banking by resurrecting the Depression-era Glass-Steagall Act and force banks to separate commercial banking (the classic function of connecting lenders to borrowers) from investment banking."

While I think reinstating Glass-Steagall would probably be a good thing, I haven't read anything that said repealing it was a contributing factor to the crisis and I've seen some things saying it was helpful because it allowed some financial firms to buy distressed firms that they otherwise wouldn't have been able to.

Still his overall point is: "The interesting question is why the president, who says he wants to get “tough” on banks, has also turned his back on changing the structure of American banks — opting for a regulatory approach instead. It’s almost exactly like health care reform. Ideas for changing the structure of the health-care industry — a single payer, Medicare for all, even a so-called “public option” — were all jettisoned by the White House in favor of a complex set of regulations that left the old system of private for-profit health insurers in place. The final health care act doesn’t even remove the exemption of private insurers from the nation’s antitrust laws. Regulations don’t work if the underlying structure of an industry — be it banking or health care — got us into trouble in the first place. "

On the point that big banks are too big to fail and therefore should be broken up, Mark Thoma doesn't completely agree. With more smaller banks, one bank failing isn't going too be too much of a problem, but there are still systemic failures that would bring down multiple banks and collectively they would still be too big to save. He does say that breaking them up would be good because it would curtail their political power. On the structural/regulatory point he says, "Much of the change that is needed is structural in nature, but not all, e.g. I'd categorize leverage limits, which I view as critical to minimizing the fallout when problems occur, as regulatory. However, as noted above structural change is harder than imposing new regulations... If we cannot muster the political will to make such changes in light of the most devastating financial collapse since the Great Depression, that does not bode well for the future."

James Kwak comments on the Regulation vs Structural Change issue. "I would add that Obama is also a political pragmatist with a strong belief that getting something done is better than nothing. I think that on health care he and the administration probably did the best they could. Remember, they barely got a majority in the House, then barely got sixty votes in the Senate, then barely got a majority in the House again (to pass the revised bill), and public opinion was very divided. But on financial reform I think they could have gotten more done. First of all, public opinion wanted more; and second, the administration lobbied against some of the most far-reaching changes, such as Kaufman-Brown and Blanche Lincoln’s derivatives spinout provision, and Merkley-Levin never got a vote."

Still, is Obama really just giving gifts to corporations? On Monday Krugman tried to measure this objectively. "How can you do that? Follow the money — donations by corporate political action committees. Look, for example, at the campaign contributions of commercial banks — traditionally Republican-leaning, but only mildly so. So far this year, according to The Washington Post, 63 percent of spending by banks’ corporate PACs has gone to Republicans, up from 53 percent last year. Securities and investment firms, traditionally Democratic-leaning, are now giving more money to Republicans. And oil and gas companies, always Republican-leaning, have gone all out, bestowing 76 percent of their largess on the G.O.P."

"One answer is taxes — not so much on corporations themselves as on the people who run them. The Obama administration plans to raise tax rates on upper brackets back to Clinton-era levels. Furthermore, health reform will in part be paid for with surtaxes on high-income individuals. All this will amount to a significant financial hit to C.E.O.’s, investment bankers and other masters of the universe." He also cites the disappointment by the left. "So what President Obama and his party now face isn’t just, or even mainly, an opposition grounded in right-wing populism. For grass-roots anger is being channeled and exploited by corporate interests, which will be the big winners if the G.O.P. does well in November."

"So where does that leave the president and his party? Mr. Obama wanted to transcend partisanship. Instead, however, he finds himself very much in the position Franklin Roosevelt described in a famous 1936 speech, struggling with “the old enemies of peace — business and financial monopoly, speculation, reckless banking, class antagonism, sectionalism, war profiteering.” And that’s not necessarily a bad thing. Roosevelt turned corporate opposition into a badge of honor: “I welcome their hatred,” he declared. It’s time for President Obama to find his inner F.D.R., and do the same."

As I recall, CFC posted a Krugman piece about a year ago in which Krugman himself admitted that Economists could not agree on or adequately explain the causes of the financial crisis in 2008.

Most unfortunately, Krugman and other classical economists still view the 2008 economic crisis as a purely economic phenomenon and refuse to consider the perspective that criminal activity was, not only involved in the crisis, but, one of its underpinnings.

This is even after civil fraud charges have been filed against Goldman Sachs.

For what's it's worth, the root cause of the 2008 collapse was excessive executive compensation run amok. By creating perverse incentives whereby senior executives of Mortgage retailers, Mortgage Wholesalers, Investment Banks, ratings Agencies, and others, could make more income for themselves (bonus money) in a year or two by supercharging current business income through the use of fraudulent financial vehicles (liars loans, AAA rated MBS on those loans, and CDS structured to fail) at the "expense of" the stability of the firms they ran, and the larger economy as a whole, they were able to generate yearly bonuses for themselves equivalent to a lifetime of pay for (hard work and results) the same position before these perverse pay systems were the norm.

Control Frauds were at the heart of the recent financial meltdown. Krugman and other respected economists need to just admit this and maybe, just maybe, the structural changes that must be implemented can get the groundswell of support necessary for "Real Financial Reform".

Until then, the Banksters just go back to counting their bonuses and to hell with the rest of us "rabble".

TT

ps. As a movie buff please identify the movie, the character and scene where the banker (most vile) uses the term "rabble".

Failure to obtain meaningful financial reform is a failure of message and of instilling political fear in the opposition.

My point is that given the fact that GC is currently under indictment by the Federal Government for financial fraud in a civil case, and that the Justice Department has publicly revealed that GS and other Banks are under investigation in criminal fraud cases, one might think it relevant to a discussion on the need for (and useable tactics to obtain) financial reform.

Yet these facts seem to be of little interest to "economic thought leaders" like Krugman. They obviously realize that financial reform is badly needed, but seem unable frame the message to make it politically obtainable.

After the Goldman indictment financial reform should have been a slam dunk, but it's not.

This just makes no sense to me. Krugman has been pushing for real reform in article after article. As have many prominent economists.

I think you're saying that since it's the CEOs who are to blame for all this (which I don't agree with) and since they committed criminal fraud (which I don't necessarily agree with) Krugman and others should be using that argument to sway public mood to make this happen.

But there are two things wrong with that.

1. Public mood was already against the banks. It was Summers/Geithner who wanted less reform and they obviously understand what happened as well as anyone. They ideologically disagree with the solution.

2. And this is my problem with this whole argument, control fraud isn't a crime, it's (potentially useful) theory put forward by Black (certainly useful for the S&L crisis it came from). But it's not actually currently against the law (which is part of its definition). If the current charges stick, then that's an argument to say the current laws are good enough which means reform isn't needed.

Were frauds committed? I believe so, but this has yet to be "proven" in a court of law.

However, what is indisputable is that the SEC believes that fraud was committed and the Justice Department appears to be currently pursuing cases of fraud according to the lamestream media.

Summers and Geithner were some of the ringleaders for financial deregulation, which paved the way for the collapse, and we should now follow thier advice???.

Summers led the charge for deregualtion under Clinton and Geithner was head of the NY FED during the years that led up to the collapse and did nothing to stop it. So we should trust their judgement to get it correct now because....

As regards control fraud not being a defined crime, that is correct.

However, the basic separate elements that constitute a control fraud such as accounting fraud, misrepresentation of financial information, manipulation of employees, are crimes.

Since you brought up during the S&L crisis, according to Prof Black, over 1,000 people went to jail for financial crimes committed during that crisis.

Using laws on the books.

Crimes and behaviours that when executed in concert constitute a control fraud.

GS is being prosecuted for misrepresentation, if I recall the specific (legal) SEC complaint filed against them. And just because current law was violated and there are succesful prosecutions, doesn't mean that additional financial reforms (regulations) would not be beneficial.